North Bank has been borrowing in the U.S. markets and lending abroad, thus incurring foreign exchange risk. In a recent transaction, it issued a one-year, $2 million CD at 6 percent and funded a loan in euros at 8 percent. The spot rate for the euro was 1.45/$1 at the time of the transaction.

a. Information received immediately after the transaction closing indicated that the euro will change to 1.47/$1 by year-end. If the information is correct, what will be the realized spread on the loan inclusive of principal? What should have been the bank interest rate on the loan to maintain the 2 percent spread?

b. The bank had an opportunity to sell one-year forward euros at 1.46/$1. What would have been the spread on the loan if the bank had hedged for- ward its foreign exchange exposure?

c. What would have been an appropriate change in loan rates to maintain the 2 percent spread if the bank intended to hedge its exposure using forward contracts? LO.1